Electing Out of Bonus Depreciation After a Cost Segregation Study

Electing out of bonus depreciation after a cost segregation study can fit when the short-life deductions the study identifies would be less useful on the 2026 return than regular MACRS depreciation, such as when §469 passive-activity limits leave the loss unusable this year, the state does not follow federal bonus depreciation, or the owner prefers recovery over the class life under §168(k)(7).

A cost segregation study changes your 2026 return by separating building costs into §1245 personal property and land improvements that may have 5-year, 7-year, or 15-year recovery periods under §168(e), instead of leaving nearly all depreciable basis in 27.5-year residential rental property or 39-year nonresidential real property under §168(c). If you claim bonus depreciation under §168(k), which is 100% for qualified property acquired after January 19, 2025, the cost segregation study can move that short-life basis into the current return (only 20% of it for qualified property acquired on or before January 19, 2025 and placed in service in 2026); if you elect out under §168(k)(7), the same cost segregation study still identifies shorter recovery lives, but the deductions are spread under regular MACRS.

When does electing out of bonus depreciation after a cost segregation study make sense?

Electing out of bonus depreciation after a cost segregation study can make sense when the accelerated deduction will not produce useful federal or state tax value on the 2026 return under the owner’s actual limits and tax posture. The election out does not make the cost segregation study useless, because the study can still reclassify qualifying costs into shorter §168(e) recovery periods and support regular MACRS depreciation over those class lives.

The first reason is federal loss usability. A rental activity is passive unless an exception applies under §469(c)(2), and a passive loss that passive income does not absorb is disallowed under §469(a) and carried forward under §469(b). If the cost segregation study creates a large rental loss and §469 leaves that loss unusable on the 2026 return, electing out of bonus depreciation under §168(k)(7) may spread the depreciation into years when passive income, a qualifying real estate professional position, or a disposition of the entire interest in a fully taxable transaction to an unrelated party makes the deduction more useful.

The second reason is state conformity. If the owner’s state decouples from federal bonus depreciation under the state’s 2026 income tax rules, claiming federal bonus under §168(k) may create a federal-state depreciation difference that the owner or CPA must track, while electing out federally under §168(k)(7) may or may not align better with the state result depending on that state’s conformity statute.

The third reason is timing preference. If the owner expects higher taxable income from the same activity in later years and can use regular depreciation more predictably, electing out under §168(k)(7) can trade one large current deduction for deductions over the applicable §168(e) class life. Cost segregation accelerates recovery of the same depreciable basis; it does not create new basis or make a project economically sound by itself.

What does placed in service mean for the 2026 bonus depreciation decision?

Property is placed in service when it is in a condition or state of readiness and availability for its specifically assigned function under Treas. Reg. §1.46-3(d)(1)(ii) and Treas. Reg. §1.167(a)-11(e)(1)(i), and for a rental property that generally means ready and available to rent. For a calendar-year taxpayer, property placed in service (ready and available for its intended use) by December 31, 2026 can be depreciated on the 2026 return under §168, while property placed in service on January 1, 2027 or later is first depreciated on the 2027 return under §168 for that calendar-year taxpayer.

For a rental bought with tenants in place, the property is usually placed in service at acquisition when the property is ready and available for its rental function under Treas. Reg. §1.46-3(d)(1)(ii). For a vacant property that needs renovation before it can be rented, the property is usually not placed in service until the renovation has put it in a condition of readiness and availability for rental use under Treas. Reg. §1.167(a)-11(e)(1)(i).

The placed-in-service article covers the readiness test and year-of-placement timing in detail. This placed-in-service rule matters here because the §168(k)(7) election out is made for the tax year the property is placed in service. A building placed in service in 2026 goes on the original 2026 return and needs no Form 3115, while a cost segregation study completed for that filing can inform whether bonus depreciation is claimed or elected out for each applicable class.

Does 2026 property get 100% bonus depreciation after a cost segregation study?

For a calendar-year taxpayer, qualified property placed in service (ready and available for its intended use) by December 31, 2026 gets 100% bonus depreciation under §168(k) as amended by OBBBA when the qualified property was acquired after January 19, 2025, and IRS Notice 2026-11 ties that acquired date to the written binding contract rules rather than merely the closing date; for property acquired after January 19, 2025, the 100% rate is permanent rather than limited to 2026, and the acquired-date article walks through the contract tests. For a written binding contract, IRS Notice 2026-11 and Treas. Reg. §1.168(k)-2(b)(5)(ii)(B) treat the acquired date as the latest of the date the contract was signed, the date it became enforceable under state law, the end of any cancellation period, and the date any contingency was satisfied.

A written binding contract for §168(k) purposes is enforceable under state law and does not limit damages to a specified amount, such as through a liquidated damages clause, under Treas. Reg. §1.168(k)-2(b)(5)(ii). Under a contract that is not binding in that sense, the acquired date is generally when the taxpayer has paid or incurred more than 10 percent of the total cost, excluding land and preliminary activities, under Treas. Reg. §1.168(k)-2(b)(5)(iii) and Treas. Reg. §1.168(k)-2(b)(5)(v).

For self-constructed property, including property built for the taxpayer under a written binding contract entered into before construction began, the property is acquired when physical work of a significant nature begins under Treas. Reg. §1.168(k)-2(b)(5)(iv), and paying or incurring more than 10 percent of the total cost, excluding land and preliminary activities, is a safe harbor under that same regulation. For qualified property acquired on or before January 19, 2025 and placed in service in 2026, §168(k) generally leaves the property on the TCJA phase-down at 20% for 2026, except for long-production-period property and certain aircraft described in §168(k)(2)(B) and §168(k)(2)(C).

Bonus depreciation under §168(k) applies only to qualified property with a recovery period of 20 years or less, which is why the 5-year, 7-year, and 15-year property identified by a cost segregation study matters. Bonus depreciation under §168(k) never applies to land, and it does not apply to the 27.5-year residential rental shell or the 39-year nonresidential real property shell under §168(c).

How is the election out of bonus depreciation made after the study?

The election out of bonus depreciation is made class by class under §168(k)(7) for the tax year the qualified property is placed in service, and the election is made on a timely filed return including extensions for that placed-in-service year. For example, an owner may elect out for all 5-year property in the §168(e) class while still claiming bonus depreciation on all 15-year property in the §168(e) class, if that class-by-class treatment is properly chosen for the placed-in-service year.

Once the §168(k)(7) election out is made, it can be revoked only with IRS consent under §168(k)(7). That rule makes the decision different from simply choosing a depreciation schedule in tax software, because the election applies to the entire class for that tax year. For property held by a partnership or S corporation, the §168(k)(7) election is made by the entity on its own return under §703(b) and §1363(c), not by each owner.

A prior election out of bonus depreciation cannot be undone through the automatic accounting method change described in section 6.01(1)(c)(vi) of Rev. Proc. 2025-23. Under the automatic change procedures of Rev. Proc. 2015-13 and section 6.01 of Rev. Proc. 2025-23, the missed depreciation is claimed on Form 3115 with no amended returns when the property has been depreciated on two or more filed returns, or on one filed return if the taxpayer placed it in service in the tax year immediately before the year of change (the year of the return the Form 3115 is filed with), and the taxpayer still owned the property at the start of the year of change and meets the other eligibility rules. That route reports the missed depreciation as a §481(a) adjustment, but it cannot reverse a prior §168(k)(7) election out.

If you placed the building in service in 2025, filed the 2025 return, and still own it at the start of the 2026 year of change, Form 3115 with the 2026 return under Rev. Proc. 2015-13 or an amended 2025 return filed before the 2026 return is filed can be available when the eligibility rules in section 6.01 of Rev. Proc. 2025-23 are met. Confirm the route with your tax advisor because the property’s placed-in-service year, filed returns, ownership at the start of the year of change, and prior elections control the available method.

How do depreciation conventions affect the bonus election?

Depreciation conventions affect regular MACRS depreciation, but bonus depreciation under §168(k) is not reduced by the mid-month, half-year, or mid-quarter convention under §168(d). Under §168(d), residential rental property with a 27.5-year recovery period and nonresidential real property with a 39-year recovery period under §168(c) always use the mid-month convention, so a real-property shell placed in service in December receives half a month of first-year regular depreciation.

Other MACRS property, including the 5-year, 7-year, and 15-year property identified by a cost segregation study under §168(e), generally uses the half-year convention unless the mid-quarter convention applies under §168(d)(3). Under §168(d)(3)(A), the mid-quarter convention applies when the aggregate basis of property placed in service during the last three months of the tax year is more than 40% of the aggregate basis of all property placed in service during that year, and §168(d)(3)(B) excludes residential rental property and nonresidential real property from that test.

For a calendar-year taxpayer, property placed in service (ready and available for its intended use) from October 1 through December 31, 2026 is property placed in service in the last three months for the §168(d)(3) test, and fourth-quarter property subject to the mid-quarter convention receives one and a half months of first-year regular depreciation under §168(d). Because bonus depreciation under §168(k) is not reduced by convention, the mid-quarter convention matters mainly for property on which bonus depreciation is not claimed, and the owner’s tax advisor should run the §168(d)(3) test for the actual placed-in-service assets.

What tax limits can make bonus depreciation less useful?

Bonus depreciation can be less useful when the resulting loss cannot be used on the 2026 return under §469, §465, or §461(l). Under §469(i), an individual who actively participates in a rental real estate activity (a separate test from material participation, and one that requires an interest of at least 10% by value (a spouse’s interest counts) throughout the year) is exempt from the §469(a) disallowance for up to $25,000 of loss from the rental real estate activities in which the individual actively participates; the $25,000 is reduced by 50% of modified adjusted gross income above $100,000 and is gone at $150,000, and for a married individual filing separately it is $12,500, phasing out between $50,000 and $75,000, only if the spouses lived apart for the entire year, and zero if they lived together at any time during the year.

Under §469(c)(7), a taxpayer is a real estate professional only if more than one-half of the personal services the taxpayer performs in trades or businesses during the year are performed in real property trades or businesses in which the taxpayer materially participates, and the taxpayer performs more than 750 hours of services during the year in real property trades or businesses in which the taxpayer materially participates (on a joint return, one spouse must meet both tests alone); the rental loss is then nonpassive only if the taxpayer also materially participates in that rental activity, with each rental tested separately unless the election under Treas. Reg. §1.469-9(g) to treat all interests in rental real estate as one activity was made.

An activity is not a rental activity when the average period of customer use is seven days or less under Treas. Reg. §1.469-1T(e)(3)(ii)(A), or 30 days or less with significant personal services provided by or on behalf of the owner under Treas. Reg. §1.469-1T(e)(3)(ii)(B), but the loss is nonpassive only if the taxpayer materially participates under Treas. Reg. §1.469-5T(a). A nonpassive loss can offset wages or other nonpassive income only when the basis rules, at-risk rules under §465, and excess business loss rules under §461(l) also allow the loss.

The cost segregation and passive activity loss article covers these tests in more detail. Under §469(g), a suspended passive loss is released, meaning it is treated as a loss that is not from a passive activity, when the taxpayer disposes of the entire interest in the activity in a fully taxable transaction (one in which all gain or loss realized is recognized) to an unrelated party. A passive loss that §469 suspends is not forfeited, because it carries forward under §469(b) and is released under §469(g) when the entire interest in the activity is disposed of in a fully taxable transaction to an unrelated party, so electing out under §168(k)(7) changes when the same depreciable basis is deducted, not how much is recovered. If that type of exit is not expected soon and current passive income is limited, electing out may still make the depreciation pattern better match the years in which the owner expects to use it.

What information should you review before choosing bonus or electing out?

The decision to claim bonus depreciation or elect out under §168(k)(7) turns on the cost segregation study results, the owner’s ability to use the deduction, and the likely hold period. A cost segregation study is worth it when three conditions hold together: the depreciable basis is large enough for the accelerated deductions to outweigh the cost of the study, the deduction is usable this year given the owner's passive-activity position, and the hold is long enough to survive recapture.

The documents a cost segregation study uses typically include the closing or settlement statement, construction costs and invoices or the contractor’s pay applications, the current depreciation schedule, and a land-value source such as an assessor ratio or appraisal. ClickDrag Finance’s review is built on the methodology in the IRS Cost Segregation Audit Techniques Guide, and the study’s output should be reconciled with the depreciation classes, bonus election, and state adjustments used on the return.

ClickDrag Finance’s cost segregation qualifier is the place to start before the 2026 return is prepared. If you are comparing providers or coordinating with a CPA, the best cost segregation companies guide can help you evaluate the process, and owners with qualified opportunity fund or qualified opportunity zone business property should also review Opportunity Zone cost segregation because OZ basis and timing rules can change the analysis.

Frequently Asked Questions

Should I elect out of bonus depreciation after a cost segregation study?

Electing out of bonus depreciation after a cost segregation study can fit when regular MACRS depreciation is more useful than immediate §168(k) bonus on the 2026 return. That can occur when §469 limits leave the current deduction unusable, when state law does not follow federal bonus depreciation, or when the owner prefers deductions over the §168(e) class life.

Does cost segregation require me to take bonus depreciation?

No, cost segregation does not require you to take bonus depreciation, because §168(k)(7) allows an election out for any class of property for the year it is placed in service. The study identifies shorter-life property, and the return decision determines whether that class receives bonus depreciation or regular MACRS depreciation.

Can I elect out of bonus depreciation for only some assets?

You can elect out of bonus depreciation class by class under §168(k)(7), not asset by asset within the same class. For example, the election can apply to all 5-year property in the §168(e) class for the placed-in-service year, while a different choice may be made for another §168(e) class.

Can Form 3115 undo a prior bonus depreciation election out?

No, the automatic change under section 6.01 of Rev. Proc. 2025-23 cannot revoke or make late an election out of bonus depreciation (section 6.01(1)(c)(vi)), and §168(k)(7) allows revocation only with IRS consent. If you placed the property in service in an earlier tax year and still own it at the start of the year of change, Form 3115 may help correct missed depreciation under §481(a) and Rev. Proc. 2015-13 when eligibility rules are met, but the prior §168(k)(7) election out remains a separate limitation.

Does electing out change the total depreciation I recover?

No, electing out of bonus depreciation does not change the total depreciable basis recovered when the property remains depreciable and other tax rules allow recovery. It changes timing by spreading deductions over the applicable §168(e) class life instead of using §168(k) bonus depreciation immediately.